Thursday, February 23, 2023

What is Your Federal Income Tax Rate?

Knowing your tax rate can help you prepare a tax return and take action(s) to reduce your tax liability. Do you know your federal income tax rate? You may actually have several different tax rates (e.g., ordinary income, dividends, long-term capital gains), depending upon sources of taxable income. This post describes the different federal tax rates that apply to taxpayers.



Ordinary Income Tax Rate- The seven federal income tax brackets for ordinary income (e.g., salary/wages, interest income, short-term capital gains, and RMDs (withdrawals) from tax-deferred retirement plans) in 2022 and 2023 are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

 

These tax rates apply currently through 2025 under the Tax Cuts and Jobs Act. Income taxes are progressive (i.e., higher percentage of income for higher income earners) and taxpayers pay different tax rates on different tiers of income up to their last dollar earned.

 

Long-Term Capital Gains (LTCG) Rate- This is the tax rate assessed on profit from the sale of a capital asset (e.g., stock, bonds, mutual funds, property). To benefit from long-term capital gains rates, an asset must be held for more than a year (e.g., a year and a day or longer).

 

Current LTCG tax rates are 0%, 15%, and 20% and, like ordinary tax rates, they rise with income. The capital gain on the sale of an asset is calculated by subtracting its cost basis (initial deposit + subsequent deposits + commissions/fees to purchase the asset) from its sales price.

 

Capital Gains on Homes- There is special rule for capital gains from the sale of a primary residence that is owned and used for at least two of the last five years prior to its sale. Single tax filers can exclude up to $250,000 of capital gain and joint filers can exclude up to $500,000.

 

Qualified Dividend Tax Rate- This is the tax rate assessed on qualified dividends that are distributed by a taxpayer’s investments (e.g., stocks and mutual funds) in taxable (i.e., non-retirement) accounts. Like ordinary and LTCG tax rates, taxes on dividends are progressive.

 

The current tax rates assessed on qualified dividends (which are reported as such by account custodians) are 0%, 15%, and 20% depending on tax filing status (e.g., single, couple filing jointly, head of household,) and income. Ordinary dividends are taxed at ordinary tax rates.

 

Effective Tax Rate- While not an “official” tax rate that people use on their income tax returns, this is a very useful metric to analyze what percentage of your taxable income is being spent on federal income taxes. Many people also use their effective tax rate to estimate tax withholding. The formula for determining someone’s effective tax rate is Tax Liability divided by Taxable Income. 

Examples: $5,000 ÷ $45,000 = 11.1% and $40,000 ÷ $245,000 = 16.3%.

 

In summary, it is not enough to simply prepare your taxes to determine if you receive a refund or write a check to the IRS. Take the time to examine the tax rates that affect your income.


This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

 

 

Thursday, February 16, 2023

Barbservations About Get Smart With Money

I recently watched the Netflix documentary film Get Smart With Money (1:33) to prepare for a discussion of the film with several dozen professional financial practitioners who are members of AFCPE. Below are my Barbservations about the film from the lens of a long-time financial educator:


Content and Format

 

Diversity and Demographics- The film featured four case study characters, each with a financial coach assisting them for an entire year. It was great to see people of color featured in both “client” and “coach” roles, but there was negligible inclusion of older, even middle-age, adults.

 

Financial Experts- All four of the “coaches” connected very well with their “clients.” However, they were all influencers (podcasters, book authors, YouTubers) without designations such as CFP®, FFC®, and AFC® and the training and depth of expertise that these credentials provide.

 

Hopeful Ending- Despite challenges such as loss of income and a car breakdown, each “client” made progress over the year. The film made it look easy, due to its time constraints, but it undoubtedly took hard work and discipline. Viewers learned that they, too, can take charge of their finances.

 

Key Financial Concepts

 

Financial Freedom- Money is a tool to reach personal goals, not a goal in and of itself. People can buy freedom with money; i.e., freedom from a 9-5 job or long commute. Financial freedom is a core tenet of the Financial Independence, Retire Early (FIRE) philosophy.

 

FIRE Math- Many FIRE proponents suggest saving 25x living expenses as “the number” to be able to declare themselves financially independent (e.g., $100,000 x 25 = $2.5 million). Aggressive savings was recommended but is very difficult to do in real life.

 

Big Three Expenses- The largest expenses for most families, with the greatest potential for expense reduction, are housing, transportation, and food. Several of the “clients” made major changes to their food shopping habits and one decided to downsize their house to save money.

 

Long Term Investing- One client was wisely instructed to make regular investment deposits to build wealth. While the “coach” suggested a S&P 500 index fund and I prefer a total stock market index fund for broader U.S. stock market exposure, long-term savings is key to success.

 

Four Questions- Author Tiffany Aliche recommended four questions to ask before buying something. Do I need it? Like it? Love it? and Want it? Focus spending on needs and loves and always build a cushion for unexpected expenses into your budget because “stuff happens.”

 

Credit Card Debt- High-APR (interest rate) debt on credit cards is like cancer. You have to cut it out. “Clients” in the film reported having “a huge weight lifted from their shoulders” after repaying what they owed. One person in the film called freedom from debt “life-changing.”

 

Financial Education- There is no price tag on financial education. Knowledge gained about managing money is priceless and can help propel people forward. Recently, more states have recognized this and have passed legislation requiring a personal finance course for graduation.


This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.


Thursday, February 9, 2023

Current Events in Personal Finance

At a recent virtual conference for financial educators sponsored by Next Gen Personal Finance, ten current trends that are impacting the world of personal finance were discussed.


Below is a brief summary of key take-aways:

 

Online Gambling- An estimated 60% to 80% of high school students, mostly teenage boys, placed a bet during the past 12 months and 36 states now have online gambling. Many students and adults think “the stock market is too risky, but gambling is not.” Ads for sports betting websites during televised sporting events are now commonplace.

 

Inflation- Since hitting a peak of 9.1% in June 2022, the Consumer Price Index (CPI) that measures inflation has been on a downward trajectory. Reasons include an easing of some supply chain shortages and smaller Federal Reserve interest rate hikes in recent months.

 

Bonds- 2022 was a bad year for bonds. Most people do not buy individual bonds but, rather, bond mutual funds that expose them to interest rate risk (the inverse relationship between interest rates and bond values). Bond values decreased with recent interest rate hikes.

 

Credit Card Debt- Most credit cards have variable interest rates and their average interest rate is about 20%. Credit card interest responds very quickly to Federal Reserve rate adjustments. Credit card debt has been increasing, evidence that families are being stretched to pay bills.


Savings Account Interest- Consumers have to move their money to niche online banks to earn attractive rates of return. However, inertia keeps a lot of money still sitting in big “brick and mortar” banks, which have little incentive to increase their interest rates very much.


ChatGPT- The tech world is abuzz about this artificial intelligence (AI) platform trained on a data set of human conversations. There are mixed impacts for education. Teachers may find it useful to write multiple choice questions but will probably have to eliminate take-home essays.


Cryptocurrency- Crypto values had a bit of a rebound in January 2023 after experiencing a series of negative events in 2022 including the collapse of the crypto exchange FTX and the failure of several so-called stablecoins. There are increasing calls for government regulation.


Financial Education Mandates- At the end of 2022, 17 states guaranteed a one-semester high school course in person finance as a graduation requirement. 2023 is expected to be an active year for additional mandates with 30 bills introduced in 10 states in January alone.


FIRE- An acronym for Financial Independence, Retire Early, FIRE proponents espouse living very frugally and investing more than half of their income in early adulthood to shorten  their working years. Being free from a 9 to 5 job provides freedom to make choices to live life on your own terms. A common goal before leaving work is to save 25x a desired annual income.


Emerging Entrepreneurship Paths- Entrepreneurs don’t need to have an office or hire others. Three emerging paths for solopreneurs (one-person businesses) are the gig economy (multiple freelance jobs, with or without a “day job”), the creator economy (developing products and services), and being an influencer (making money by influencing the buying habits of others).

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

 

 


Wednesday, February 1, 2023

The Curious Case of I-Bonds: Too Good to Be True?

I can’t think of any other investment, off the top of my head, where the rate of return earned two decades ago continues to directly influence what I receive today…with the exception of Series I-bonds issued by the U.S. Treasury. Of course, early compound interest earned also impacts later investment growth, but I’m talking about investment features per se.



Personal Connection

Earlier this week, as part of an annual net worth (assets minus debts) review, I checked to see the value and current interest rate being paid on my twelve I-bonds purchased between 2001 and 2006: three were paying 12.76%, three, 11.30%, and six, 7.51%...at least for a six month period. The current rate paid on I-bonds issued through April 30, 2023 is 6.89% and the current fixed rate component is 0.40%. From May 2020 through October 2022, the fixed rate was 0.0% (zero).

 

Fixed Rate Advantage

How can I be earning more than the current interest rate paid on newly issued I-bonds? Thanks to the high embedded fixed rates of a bygone era when I-bonds could be purchased in person at financial institutions instead of through a clunky website. Since I-bonds were first issued in September, 1998, the fixed rate has ranged from 0% to 3.6% and is adjusted semi-annually. The earliest I-bond adopters (late 1990s) earned as much as 13.39% from May to October of 2022.


I-Bond History

But I’m getting ahead of myself. First, some savings bond history. U.S. savings bonds (Series EE) began in 1935 and inflation-indexed I-bonds, as noted above, began in 1998. In 2008, bond purchases became available electronically and in 2012 paper U.S. savings bonds were no longer issued by financial institutions. Instead, investors were directed to the Treasury Direct website.


Interest Rate Calculation

I-bonds, like any other government bond, are a loan to a government entity, in this case, the federal government. They are currently a high-yielding, low-risk investment paying almost twice the interest rate on a 30-year Treasury bond and about 30x the average savings account rate (0.23% on January 25). Interest is earned monthly and compounded semi-annually. Thus, every six months, interest is applied to a new principal value (i.e., old value + interest earned).


Semi-Annual Interest Rate Changes

The interest (earnings) rate for I-bonds consists of a fixed rate component that remains the same over the life of the bond plus an inflation factor, which is based on the last six months’ Consumer Price Index (CPI). I-bond interest rates are updated every six months on May 1 and November 1 and interest on I-bonds is payable for up to 30 years from their purchase date.


Purchasing Methods

Unfortunately, there is no advertising to tell people about I-bonds. Up to $10,000 of I-bonds can be purchased electronically down to the penny (e.g., $178.36) through Treasury Direct and up to $5,000 (in different increments) of “old school paper I-bonds” (like I have) via a tax refund. I have seen online chatter recently by some people who significantly over-withhold income tax to buy paper bonds to avoid online hassles. When purchasing I-bonds online, investors must provide their Social Security number or other taxpayer ID and bank routing/account number.


The Real Deal

In summary, we have experienced a historically high inflationary time period these past two years which makes I-bonds a very attractive place for cash assets. The rate of return on I-bonds will eventually decrease when inflation decreases, but it will never fall below zero so investors can’t lose money. I-bonds are not “too good to be true” if you understand how they work and their limitations (e.g., annual purchase limits and inability to cash out within a year of purchase).


This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.


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